Energy Transfer Shares Surge During Merger Trial With Williams

By Leslie Picker

June 21, 2016

GEORGETOWN, Del. — In March, Brad Whitehurst, head of tax at Energy Transfer, the pipeline operator, discovered there might be a problem with the $38 billion merger his company had signed with the Williams Companies six months earlier. He had misunderstood the terms of the deal, and with the rapid decline of Energy Transfer’s shares in the intervening months, the transaction no longer appeared to be tax-free.

The problem was that the completion of the merger required the assurance that it would not incur a tax liability.

Mr. Whitehurst immediately called Latham & Watkins, Energy Transfer’s outside legal counsel. After parsing through the details again, lawyers at the white-shoe law firm also determined they had made a mistake in structuring the deal and could no longer provide the necessary opinion letter to close.

Williams’s outside lawyers, from Cravath, Swaine & Moore, considered Latham’s argument to be “bogus” and presented two proposals to restructure the deal. Both were promptly rejected by the lawyers at Latham.

Coincidentally, the debate over the deal’s tax status paralleled a steep decline in pipeline industry shares, which gave Energy Transfer the incentive to get out of the deal, while making it imperative for Williams to stay in and close it.

This was the narrative woven in testimony on Monday and Tuesday, as both sides came together at the Delaware Court of Chancery here for an expedited trial examining whether each side was engaging in its best effort to close the deal.

The stakes are high on both sides. Each has accused the other of breaching the merger agreement. Williams shareholders will vote on the merger in less than a week, and Energy Transfer hopes the judge will find enough reason to kill the deal.

Six of the eight witnesses during the two-day trial were tax lawyers and experts who debated the merits of Latham’s argument for not offering an opinion letter and rejecting Cravath’s alternative proposals.

By midday Tuesday, Sam Glasscock III, the vice chancellor of the Court of Chancery, dropped a bombshell: He did not care if Latham was right or wrong in refusing to issue its tax opinion. He just needed to be sure that Latham was acting in “good faith.”

That sent hedge funds and investors scrambling out of the room to make trades. Mr. Glasscock’s words seemed to fuel the 17 percent gain in Energy Transfer’s shares in trading on Tuesday, reflecting optimism that the deal would fall apart or be recast in a way that benefited Energy Transfer.

The challenge for Williams was to show ample evidence that Latham was withholding the tax opinion because it was influenced by its client’s wishes to get out of the deal.

Jamie Welch, who had been chief financial officer of Energy Transfer until he was abruptly fired in February, said in a video deposition that Kelcy Warren, the chairman of Energy Transfer, was concerned the cash-and-stock deal would result in a ratings downgrade and create an “implosion.” Mr. Warren attended most of the trial but did not testify.

More important, to the judge, perhaps, was not whether Energy Transfer wanted out of the deal but whether Latham helped them try to get out of it.

The stock price decline created a mismatch in the movement of assets and cash between Williams and a newly created subsidiary of Energy Transfer, or what Latham called “the perfect hedge.” One tax expert, Bill McKee of the law firm Morgan, Lewis & Bockius, had been summoned by Energy Transfer to provide a tax opinion in addition to Latham’s. Mr. McKee, who had been a former partner of Mr. Whitehurst’s, admitted as a witness that he did not understand the “perfect hedge argument” at the time and does not understand it now.

At the end of the day, Morgan also determined it could not provide the tax opinion if requested to do so.

Mr. Glasscock said he planned to deliver an opinion by Friday evening. If the two sides settle in the interim, Mr. Glasscock said, they should let him know.

A version of this article appears in print on , Section B, Page 5 of the New York edition with the headline: Energy Transfer Shares Surge After Comments During Merger Trial With Williams. Order Reprints | Today’s Paper | Subscribe